Monday, 24 February 2020

"Zero Carbon" and Finance

Anything as big as the "zero carbon" thing is going to have impacts on all fronts - which is rather the point, of course.  And while some firms and banks are revelling in the Keynsian decarbonisation / adaptation bonanza (as we've discussed here several times) there are plenty of negatives to be considered - and not just for German diesel manufacturers.  If we take the underlying phenomenon at face value, this rather odd article reckons climate change itself will bring about a major recession, or maybe even "the next financial meltdown".  Its reasoning isn't too subtle however ("natural disasters pose a threat to businesses"): and being RT it may well have misunderstood the publication it is summarising.  

I would, however, be interested to hear from the insurance industry - or maybe I've missed it (anyone got a good link?) - about how 2019-2020 weather etc ranks in their scale of problematic pay-outs, and how many more such years they can handle before rates really start to rise.  That could be an effective brake on business development, and once again will cause governments to be leaned upon to socialise the risks, which is becoming a habit - often a lazy habit - across several sectors of late.

My main interest in this area is rather different, however.  When engaging with financiers on big projects, I've always been struck by how much weight they put on the tail-end of a projected cashflow stream.  In my industry, 15-year finance is pretty much the norm for many classes of big asset, with payback targetted anywhere between 5-10 years.  When I first became involved, I was gobsmacked to find the banks demanding projections of project revenues out 40 years!  which only makes sense at all for a few assets - most will be finished at around the 25-year mark.  OK, a very long-lived asset might be seeking the very cheapest finance, and hence the discount rates being used will be very low ... but 40 years?!

And now, most western governments are positively targetting, and usually "legislating" (FWIW) for epic structural transformations a mere 10-15 years into the future, with further disruptions all the way to 2050.  Safe to say, there's virtually no asset, even a nuke or a pipeline with a putative 60 year life, for which serious projections could be made even as far as the magical year 2050.  And we don't even need to opine on whether this makes sense, or will succeeed.  They're doing it: that's all we need to know.

There are only so may ways this can go.

(1) the banks can admit their prior interest in the tail-years' cashflow was primarily academic, or just for icing the cake, either of which they can forgo if push comes to shove.

(2) with bugger-all visibility of business dynamics beyond 2035, a whole heap of potential projects (particularly "conventional energy") will find their cost of capital rising noticeably, all the way up to prohibitive; and a raft of these projects will simply not fly any more (just as many existing assets will become stranded by related phenomena).

(3) everyone will gang up on governments, demanding (yes, you guessed) the problem be socialised, probably with governments standing directly behind the debt servicing (as the nuke boys have been demanding for years).  Everyone will be wanting this privilege for everything that moves, most particularly the ever-widening category of what counts as "green" investment which, as we've pointed out several times in recent months, now encompasses "adaptation" projects (and for leftists, of course, includes projects that are part of the "just transition", = anything they fancy with plenty of unionised jobs involved, see the Labour 2019 manifesto passim).

This whole thing is of course entirely a self-fulfilling problem.  Doesn't make it any the less real.  You can see why the leftists and nationalisers have their tails up, just as do the putative "war profiteers" among the banks and the engineering companies for slightly different reasons.  (And the NGOs, the con artists, the kleptocrats, and doubtless organised criminals too.)  They can't all be right.  Indeed, as we've said before, they will be fighting it out in the trenches for the rightness of their own, very partial vision of this future.  And their hands on the pension funds ...



Moorman said...

Dunno what assets you are talking about here, but 40 years seems like a pretty short timescale from where I'm standing. The railway line to my local station was completed in 1876. My house was built in about 1880. I've got a coat in my wardrobe that was issued to my father as part of his uniform in 1970. Given five minutes I'm sure I can find coins in my loose change that were issued not long after the introduction of decimalisation. Sure, I'd be hard pressed to find a usable 40 year old toothbrush, or a computer that was doing meaningful work 40 years later. However, a 40 year old coffee mug isn't that hard to find, nor a 40 year old car. Longevity shouldn't be overlooked.

Nick Drew said...

The longer the asset life, the more emphasis banks will put on revenues out into the distance (in order to justify the low interest rates), = the bigger problem when the whole business / economic world will be turned on its head in the period 2030-2050.

Nick Drew said...

PS, for the avoidance of doubt - as a conservative (and someone with plenty of grey hair), I'm a great fan of longevity!

Raedwald said...

The current edition of the Treasury Green Book specifies, to be used in project option appraisal, a GDP deflator of 2% (not unreasonable) but a discount rate of 3.5%. 3.5%. How?

The Green Book annex states "As recognised in the 2003 Green Book there are a range of estimates of the individual components of the discount rate. Research continues to illustrate a range of plausible estimates but concludes that the overall discount rate of 3.5% remains within that range and is justifiable."

What rate are you using in your CF forecasts Mr D?

Nick Drew said...

Would be higher, as I'm engaged in private sector (mostly non subsidised!) projects, i.e. higher risk, higher required return, less interested in distant speculative cashflow. But the banks will use lower than be because they have higher priority on surpluses and will have portfolio offsets that I don't see

Nick Drew said...

By surpluses, I mean free cashflow arising from the project (debt etc takes precedence over equity)

Raedwald said...

After a number of years, the figures on a DCF become almost irrelevant - the higher the DR, the more rapidly the scheme must produce returns as the sooner later cash flows become irrelevant. So commercial schemes reflect the sort of short-termism of which governments are always accused, but I'm surprised that banks should use a lower DR than government - one would expect them to be as short termist as investors. For infrastructure schemes such as rail improvements, stuff with land acquisition, I would expect the Treasury to use a much lower rate, no?

Nick Drew said...

Yes indeed - if they (we!) - are paying or underwriting: sovereign govt printing its own money = cheapest finance of all

Elby the Beserk said...

Climate change they wail as we sink into a Grand Solar Minimum.

Models are very angry - climate not doing what it is meant to be doing. Witness **rapid** cooling in the North Atlantic.

"From 2008 to 2016 a widespread cooling ranging from 0.6°C to more than 2.0°C has chilled effectively the entire oceanic region from E. Canada to N. Iceland to S. Europe. The cooling persists year-round and extends from the surface down to depths of 800 m."

Models forecast the opposite. Why? Because they use CO2 as the main driver parameter. Not the sun.

Going to be a hoot when our energy prices quadruple as we sink into a mini Ice Age. What fun.

Anonymous said...

Great stuff Elby. History is littered with people who think they can command nature. Apart from the Dutch, I can't think of anyone coming close.